Cory H. Smith
159 T.C. No. 3 (2022)
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Rule of Law:
A closing agreement under I.R.C. § 7121 is final and conclusive and will not be set aside unless a party demonstrates fraud, malfeasance, or misrepresentation of a material fact. Statements of law or legal conclusions in an agreement's recitals do not constitute a misrepresentation of material fact for the purpose of setting aside the agreement.
Facts:
- Cory H. Smith, an engineer, accepted an offer of employment from Raytheon Company, a private defense contractor, to work at the Joint Defense Facility at Pine Gap in Australia.
- To avoid double taxation, the U.S. and Australian governments had an arrangement where U.S. employees at Pine Gap could be exempt from Australian tax if they paid U.S. tax on their income.
- This required the U.S. employee to waive the right to elect the foreign earned income exclusion under I.R.C. § 911(a) by executing a formal "closing agreement" with the IRS.
- Smith's employer, Raytheon, presented him with form closing agreements, which he signed on multiple occasions. Raytheon acted as an intermediary, transmitting the forms between Smith and the IRS.
- In 2016, Smith signed a closing agreement covering the taxable years 2016, 2017, and 2018 (the '2016–18 Closing Agreement').
- Deborah Palacheck, in her official capacity as the Director, Treaty Administration, for the IRS Large Business and International Division, signed the 2016–18 Closing Agreement on behalf of the Commissioner of Internal Revenue.
- Despite having signed the agreement, Smith later claimed the section 911(a) foreign earned income exclusion on his amended 2016 and 2017 returns and his original 2018 return.
Procedural Posture:
- After initially filing his 2016 and 2017 tax returns consistent with the closing agreement, Cory H. Smith filed Forms 1040X, Amended U.S. Individual Income Tax Return, claiming the section 911 exclusion, and the IRS issued refunds.
- Smith also claimed the section 911 exclusion on his original 2018 income tax return.
- The Commissioner of Internal Revenue issued a notice of deficiency to Smith for the 2016, 2017, and 2018 tax years, disallowing the section 911 elections and asserting the refunds were issued in error.
- Smith, as petitioner, timely petitioned the United States Tax Court for a redetermination of the deficiencies.
- Both Smith and the Commissioner, as respondent, filed competing Motions for Partial Summary Judgment regarding the validity of the 2016-18 Closing Agreement.
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Issue:
Does a closing agreement entered into under I.R.C. § 7121, in which a taxpayer waives the right to a foreign earned income exclusion, become invalid or subject to being set aside due to an alleged lack of signature authority by the IRS official, alleged malfeasance through the disclosure of tax information, or alleged misrepresentations of law in the agreement's recitals?
Opinions:
Majority - Toro, J.
No, the closing agreement is not invalid and may not be set aside. The court found that the agreement is valid and enforceable. First, the IRS official who signed the agreement, the Director of Treaty Administration, possessed the requisite authority to do so. This authority was properly delegated under Delegation Order 4-12, which allows the Director to act as a 'competent authority' and sign 'other agreements' to implement tax treaties, such as the 1982 U.S.-Australia treaty. Second, there was no malfeasance 'in the making of the agreement' that would justify setting it aside. The IRS's use of Raytheon as an intermediary did not constitute an improper disclosure of confidential return information under I.R.C. § 6103 because a blank form is not 'return information,' the taxpayer himself disclosed his information to his employer, and any improper disclosure by the IRS occurred after the agreement was already final and conclusive. Third, the alleged misrepresentations in the agreement's recitals were conclusions of law regarding Australian tax liability, not misrepresentations of material fact. Section 7121(b) only permits setting aside an agreement for a misrepresentation of material fact, not a misrepresentation of law.
Analysis:
This decision strongly reinforces the finality of I.R.C. § 7121 closing agreements, emphasizing that courts will strictly enforce them and narrowly construe the statutory exceptions for setting them aside. The case clarifies that misstatements of legal conclusions, as opposed to facts, are not grounds for invalidating a closing agreement, meaning parties are bound even if the underlying legal interpretation is debatable. The ruling also provides important guidance on the scope of delegated authority within the IRS for international tax matters, confirming that officials like the Director of Treaty Administration can execute such agreements under broad delegations. It sets a high bar for claims of malfeasance, requiring that any wrongful act must have occurred 'in the making of the agreement' and induced the taxpayer's consent.
